Economist
January 7, 2012
There has been an ongoing debate over just how profligate some euro-zone economies were prior to the present debt crisis. Some, like Greece, were obviously irresponsible. For other economies, however, the case is not so clear. Paul Krugman has repeatedly pointed out that Spain was behaving as one might hope before the crash, budgeting responsibly and cutting its debt-to-GDP ratio. Others—among them my colleague—respond that Spain's seemingly sound budget relied on unsustainable capital inflows and was therefore recklessly loose. In the future, they argue, any euro-zone fiscal rules should take into account large capital inflows and require that fiscal policy tighten in response to them in order to prevent dangerous shocks.
These commenters have a point; Spain's fiscal balance created a false sense of comfort unjustified by the gross capital flows facing its economy. But is it reasonable to ask fiscal policy to lean against these inflows? Can tight budgeting prevent the growth of the kinds of imbalances that led to the present European crisis?
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